Debt Financing: Takes the form of loans that are repaid over time with a certain additional percentage in the form of interest. Usually businesses can borrow money over a short term period which is classified as less than one year, or long term for more than one year. The main sources of debt financing are:
Debt financing offers businesses a tax advantage, due to the fact that interest paid on loans is tax deductible as a business expense. But using debt financing can sometimes prove difficult especially with small business, where they can struggle to make regular loan repayments if they have irregular cash flows. Therefore, and to avoid this problem, it is very important for the SME to have a very good and realistic cash flow forecast for its business before approaching the debt provider. This will contribute in structuring the payback arrangement based on this cash flow, and avoid facing any difficulties in the future.
Moreover, carrying too much debt can also create a big problem because it increases the risks associated with the business overall. It increases the leverage ratio of the business. This may make the business unattractive for equity investors and therefore reduce your capability to raise capital in the future.
Banks
Leasing companies Factoring companies
Issuing a bond, if the company is listed. This however, requires that the company is sizable and has strong credit rating, and generates significant cash.
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of financing to undergo, whether debt financing or equity financing or maybe both. Financing projects through debt can result in a liability or an obligation that must be serviced, and would have implications on the cash flow and therefore have an impact on the project’s success. Equity financing is less risky with regards to the cash conversion cycle of your company; however it has other implications in the form of ownership and control and participation in earnings. Other factors to consider would be the cost of the capital to be raised. Typically, the cost of debt in the form of interest rate payment should be less than the cost of equity in the form of required return on investment by the equity investor. However, where interest payment is an obligation, profit sharing is subject to agreement with the shareholders and can be deferred for the future if the company is in need to reinvest its earnings.
G u i d e o n A c c e s s t o F i n a n c e 61 Sec tion 3 Ho w t
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t financing option f
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our c
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• Your Cash Conversion Cycle • Your Debt to Equity Ratio
• Interest rates applied by the debt financing institutions • Forecasts and feasibility analysis of your capital project
Private equity funds Venture Capitalists Individual investors
Stock issues (for companies listed in NILEX)
Strategy and Business plans
Type of investors, (specialized in your field, or general ) Forecasts and feasibility analysis
Equity financing: Takes the form of money obtained from investors in exchange for a share in the business. At the early stages of a business such funds may come from friends or family of the business owners, and through venture capitalists.
Essential things to consider before taking the decision to raise debt financing for your business:
The main advantage of Equity Financing is that there are no obligations to repay the money, but the equity investors obtain a corresponding share of the business, based on the agreed value of the company. The investors gain their money back through future profits. Note that the profile of the investor may help in increasing the credibility of a new business, which would help the company raise capital in the future.
Using Equity Financing requires a company to be willing to open up to new partners who will participate in the strategic management of the business. Those partners usually bring in more experience, a fresh perspective, and professional management practices to the business. Their financial support and coaching can help the original founders of the company achieve much better results for the business, hence increasing the value of the company. In return, the equity investors take a stake of the business and the future returns, as pay back for their invested capital.
By now you should have a clear idea of what it is that your company needs financing for, and whether they are long term finances or short term finances, and choosing the most suitable type of financing (debt or equity) in order to seek the right type of institution. • • • • • • •
Essential things to consider when finding investors for your business: For Equity financing, financial institutions include:
Section 4
G u i d e o n A c c e s s t o F i n a n c e 63 Sec tion 4 Ho w t o get tha t mone y